Hostile Resistance To Hedge Fund Activism
Nicole M. Boyson
Northeastern University – D’Amore-McKim School of Business
Pegaret Pichler
Northeastern University, D’Amore-McKim School of Business, Finance Area
July 6, 2016
Abstract:
Target firms openly resist hedge fund activists about one-fourth of the time, via poison pills, lawsuits, and restrictions on shareholder actions. Target firm resistance is met with a significantly negative market reaction, reducing the initial positive reaction to activism announcement. Unless hedge funds counter-resist with a proxy fight or lawsuit, targets are less likely to accede to hedge fund demands, be acquired, or experience improved long-term operating performance compared to non-resisting targets of the same hedge funds. By contrast, when hedge funds counter-resist, target firm outcomes do not differ relative to non-resisting targets of the same hedge funds.
Hostile Resistance To Hedge Fund Activism – Introduction
“Prevention of, or response to, an activist attack is an art, not a science.” – Martin Lipton, creator of the poison pill.1
A large and growing literature examines the role that hedge fund activists play in corporate governance. Brav, Jiang, Partnoy, and Thomas (2008) and Klein and Zur (2009) document a positive stock price reaction to hedge fund activism that does not reverse over the next year. These and other authors also find evidence for positive changes in long-term policies and operating and stock performance (see Clifford (2008), Becht, Franks, Mayer, and Rossi (2009), Boyson and Mooradian (2011), Bebchuck, Brav, and Jiang (2015), Brav, Jiang, and Kim (2015), and Boyson, Ma, and Mooradian (2016), among others). Greenwood and Schor (2009) argue that hedge fund activists put firms into play for potential takeovers, and Boyson, Gantchev, and Shivdasani (2016) find that merger-related activism results in positive outcomes for both targets and bidders, even if firms are not eventually acquired.
Numerous media accounts indicate that public companies fear activists, and spend significant resources crafting responses to the threat of activism. Martin Lipton, the creator of the poison pill, outlines a comprehensive approach to resist activists, arguing that, “Hedge fund activism requires attention and warrants similar preparation as to that we recommend for responding to a hostile takeover bid.”2 Despite academic research that supports the effectiveness of activism, target firms do not typically embrace the appearance of an activist, since dealing with activists is costly and time consuming and can lead to disruptive operating changes or even takeovers. Target firms also frequently argue that activist goals are too short-term in nature. A March 2016 article in CFO magazine called, “Activists at the Gate…Here’s how to Keep them at Bay” reflects this view. Additionally, a piece in the New York Times notes:
…Mr. Icahn has also made an art of eking out extra pennies from companies. A hostile takeover ends the matter because the company is acquired, but shareholder activism can take many forms and might not be long lasting, leaving the company to flounder in the public markets. But unlike hostile takeovers, there is a real fear on Wall Street of the activists.
Despite this widespread concern by managers of target firms, no comprehensive academic study has investigated target firms’ responses and resistance to activism, nor the impact of resistance on activism success and target firm performance.4 To fill this gap, this paper considers the impact of target firm resistance on hedge fund activism.
We begin by showing the prevalence of and methods by which target firms resist hedge fund activists. In a sample of about 1,000 activist events from 2000-2012, target firms openly resist hedge fund activists within one month of activism in 23% of events. Modes of resistance include strengthening or adopting or poison pills, filing lawsuits, making it more difficult for shareholders to call special meetings or act by written consent, changing voting requirements, and/or classifying the board. In about two-thirds of campaigns with resistance, the hedge fund counter-resists by initiating a lawsuit or a proxy fight.
Of course, we cannot observe all resistance by target firms. Target firms frequently engage in private negotiations with activist hedge funds. We assume that these private negotiations are a natural and essential component of the activism process, and that they usually lead to some type of compromise between activists and target firms. Our main focus is therefore on more hostile and overt forms of resistance. In these cases, we assume that target firms and activists attempted to reach an acceptable compromise but were unable to do so, leading to escalating hostility by the target firm, and often by the activist. As such, we use the term “resistance” throughout the paper to refer to situations where we can directly observe or infer target firm resistance, and not to the normal negotiation process inherent to all campaigns.
As in earlier studies, the stock market responds favorably to hedge fund activism. In addition, the market does not anticipate the resistance: the average 3-day cumulative abnormal return (CAR) around the announcement of activism for future resisters is about 3%, not significantly different from future non-resisters. The stock market responds negatively to resistance, with a 3-day CAR of -1.5% around the announcement of resistance. For cases in which the hedge fund counter-resists the activist, the market responds positively to the counter-resistance with a 3-day CAR of 1.9%. These CARs do not reverse over the next month. These results imply that target firm resistance has the potential to reduce the positive impact of activism, and that hedge fund counter-resistance has the potential to ameliorate the negative effect of target firm resistance. We test these ideas throughout the remainder of the paper.
We model the target firm’s decision to resist activism, the hedge fund’s decision to counter-resist, and the target’s decision to accede (or not) to hedge fund demands as a sequence of choices by the participants. This approach takes the decision to initiate activism as given, and hence, the entire sample consists of activist targets.5 By focusing only on activist targets, the paper examines cross-sectional differences between 1) firms that resist but do not meet counter-resistance from hedge funds, and 2) firms that resist and do meet counterresistance from hedge funds via a proxy fight or a lawsuit. These subsets of resistance campaigns are compared to 3) activism campaigns initiated by the same hedge funds in subsets 1) and 2) but against which targets do not resist. To avoid look-ahead bias, the events in subset 3) must occur subsequent to at least one campaign by the same hedge fund in which the target firm did resist. Since the hedge funds are the same in all three subsets, this approach should help control for unobserved heterogeneity in hedge fund manager skill. Subset 4 includes campaigns by hedge funds against which target firms have never resisted prior to the current campaign.
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